SolutionA)

Verbrugge Publishing Company

Balance Sheet
Assets

Amount

Current Assets
Net Fixed Assets
Goodwill

$ 159.00
$ 153.00
$
15.00

$ 327.00

B)

C)

Verbrugge Publishing Company

Income Statement
Particulars

Amount

Net Sales
Operating Expense

$ 540.00
$ 516.00

Net Operating Income

Other Income
Interest Expense

$
$
$

24.00
3.00
7.20

Earnings before tax

Taxes @ 50%

$
$

19.80
9.90

Net Income
Dividend on Preferred Stock

$
$

9.90
2.88

Income available to common stockholders

7.02

The earnings required before the recapitalization is $7.8 million/(1 - 0.5) = $15.6
million. We divide the preferred dividends by (1 - T) since $15.6 million must be
earned to provide the $7.8 million needed after-tax. After recapitalization, the
firm requires $2.9 million/0.5 = $5.8 million to cover the preferred dividend
payment, and $7.2 million to cover the interest expense for a total of $13.0

million. Since interest expense is tax deductible, only $7.2 million in pre-tax
earnings are required to cover the interest expense. Thus, required earnings will
decrease by $15.6 million - $13.0 million = $2.6 million if the reorganization
takes place.

D)

Before reorganization:
Debt Ratio = ($42 + $78) / $336
Debt Ratio

35.71%

After reorganization:
Debt Ratio = ($42 + $78 + $90) / $327
Debt Ratio

64.22%

The reorganization shall not take place because the debt ratio has increased due to the re

Publishing Company
alance Sheet
Liabilities

Amount

Current Liabilities
Advance Payments
8% Debentures
Reserves
$2.4 Preferred Stock, par value $37.50
Common Stock, $1.50 par value
Retained Earnings

$
$
$
$
$
$
$

8 million/(1 - 0.5) = $15.6

ce $15.6 million must be
er recapitalization, the
e preferred dividend
e for a total of $13.0

42.00
78.00
90.00
6.00
45.00
9.00
57.00

$ 327.00

7.2 million in pre-tax

us, required earnings will
if the reorganization

bt ratio has increased due to the reorganization.